Exit Strategies for TradersExit Strategies for TradersThe Good, the Bad, and the Ugly

A presentation byA presentation by Chuck LeBeau

Director of Analytics, www.SmartStops.nety , p

Legends of Trading ForumLegends of Trading ForumChicago 2010

What we intend to coverProblems with most trailing exits

The good, the bad, and the ugly

Proposed solutionsChandelier exitsModified Parabolic

Targeted exits for short-term traders

Other methods to exit on strength

Challenges of using trailing stops

1. Always know when to sell

2 Li i i k & i i fi

Most popular methods of setting trailing stops are

2. Limit risk & maximize profits

3. Avoid “whipsaws”

seriously flawed

We will now look at some 4. Have a reentry

5. Ease of use

common methods of setting stops and discuss their strengths and weaknessesstrengths and weaknesses

Percentage trailing stopsThe Good:

Ease of calculationsObjective (no chart analysis)j ( y )

The Bad:Stops get closer or farther away based on price levelsNo adjustment for trend strength or directionNo adjustment for trend strength or directionNo research on what percentages work best (8%, 10%, 25% or some other percentage ???)

The Ugly:The Ugly:Subtract percentage from where? From entry? From recent high?After price breaks by selected percentage – where is next stop?

Moving Average trailing stopsThe Good:

Ease of calculationsObjective (no chart analysis)j ( y )

The Bad:Which moving average should you use?No adjustments for direction of trendsNo adjustments for direction of trendsNo adjustment for changes in volatility

The Ugly:Too slow rapidly rising prices quickly get too far away from MAToo slow- rapidly rising prices quickly get too far away from MAAfter MA is broken – where is next stop?They will drive you crazy in sideways markets!!

Exit at “Support levels”

The Good:No calculations

The Bad:Highly subjective – expert chart analysis requiredSupport levels do not move up as prices accelerateNo adjustment for changes in direction or volatility

The Ugly:The Ugly:Too slow- Rapidly rising prices quickly get too far awayNot suited to downtrends – where is next stop?

Exit at Trend LinesExit at Trend Lines

The Good:No calculations

Th B dThe Bad:Highly subjective – expert chart analysis requiredNo adjustment for changes in direction or volatilityF t hi i id k tFrequent whipsaws in sideways market

The Ugly:T l R idl i i i i kl t t fToo slow- Rapidly rising prices quickly get too far awayNot suited to downtrends – where is next stop?

Exit at Parabolic SARExit at Parabolic SAR

The Good:Accelerate very quickly to keep pace with rising prices

Th B dThe Bad:Complicated calculations requiring computer and softwareNo adjustment for changes in direction or volatilityF t “ hi ” i id k tFrequent “whipsaws” in sideways markets

The Ugly:N t it d t d t d h i t it?Not suited to downtrends – where is next exit?Does not let profits run for big gains

Exits at SmartStops.netpThe Good:

Cuts losses short while letting profits runCuts losses short while letting profits runAutomatically adjusts to trend directionAutomatically adjusts to changes in volatilityCompletely objective – no charts to readCompletely objective no charts to readProvides exit prices in advance of useChoice of short-term and long-term time framesTimely email notification when exit prices are hitWhen necessary, exits move farther away to avoid whipsaws

The Bad:Service is only free for 14 days on a trial basis

The Ugly:There is no gl SmartStops are beautiful!There is no ugly – SmartStops are beautiful!

Quick comparison Q pto “buy and hold”

From the beginning of 1998 thru July 2009, a buy and hold approach using 1,000 shares of the SPY (ETF for the S&P 500) would have lost $6,940.

If SmartStops exits were combined with a simple reentry at 20 day highs over the same period the result would have been a profit ofhighs, over the same period the result would have been a profit of $52,970.

The SmartStops exits improved results over this ten-year period byThe SmartStops exits improved results over this ten year period by a total of $59,910!

How the SS strategies work1. The exits are adjusted according to trend direction:

In an uptrend the exits trail at a distance in order to let pprofits run.

In a downtrend the exits are moved closer to protect moreIn a downtrend the exits are moved closer to protect more capital.

I id k h i il j id h fIn sideways markets the exits trail just outside the range of random price swings to avoid “whipsaws”.

How the SS strategies workHow the SS strategies work2 The exits are accurately adjusted to changes in2. The exits are accurately adjusted to changes in volatility as measured by Average True Range:

The “normal” price ranges are mathematically defined in units of ATR.

To avoid “whipsaws”, the exits are placed outside the normal price swings.

Only an “abnormal” period of weakness will trigger an exit signal.

RangeTrue Range

“True” range adjusts for gapsTrue range adjusts for gaps

How the SS strategies workg3. In upward trending markets the “Chandelier Exit”

allows the exits to keep up with price acceleration:p p p

A stop is placed (3?) Average True Ranges from the highest high since entry of the trade or the highest high over some defined period of time.

Because the stop is attached to the high point it moves up at the same rate that the high moves.

The length of the chain on the Chandelier is measured in units of ATR and will automatically adjust to changes in volatility.

Adjusting the chain on the Chandelier Exit keeps the stops from getting too close or too far away.

How the SS strategies workg4. A highly modified Parabolic indicator allows the

stops to gradually accelerate without getting toostops to gradually accelerate without getting too close:

Th P b li i difi d t k it l l i di t d itThe Parabolic is modified to make it a long-only indicator and it never reverses.

The acceleration of the Parabolic is slowed so it does not accelerate tooThe acceleration of the Parabolic is slowed so it does not accelerate too fast.

The Parabolic is modified so that it is not allowed to move inside the e a abo c s od ed so a s o a owed o ove s de erange of normal price activity.

How the SS strategies workHow the SS strategies work

5. Combine the exit signals with a foolproof and g pintelligent method of reentering trades after an exit:

Try to find indicators such as MACD and ADX that can signal when y gstrength has returned to a position you may have previously sold.

Our research has shown that following a reentry methodology as simple as the “Donchian 4-week breakout” or the “Turtles 20-day breakout” would prevent missing any major opportunities.

S S i h d Wh h d iSmartStops uses two proprietary reentry methods. When the trend is down the reentries are slow to trigger. When the trend is up the reentries will trigger quickly.

Advice: Overcome “Whipsaw” ParanoiaThe only way to completely avoid whipsaws is to not use protective stops. Unfortunately that drastic solution would expose investors to unacceptable levels of risk.

In order to mitigate the consequences of a premature exit signal, a plan of reentering needs to be in place.

Our studies clearly show that, in the long run, the benefits of using y , g , gprotective trailing stops will far exceed the expense or lost opportunity costs of an occasional whipsaw.

Learn to accept the occasional whipsaw as simply a cost of doing business and make sure that you are always prepared to reenter if a strong upward trend is resumed.g p

Ad iAdvice: Learn “Position Sizing”Use your protective stops to determine your correct “position size” HereUse your protective stops to determine your correct position size . Here are the simple steps:

1. Select a percentage level of risk relative to the size of your portfolio.1. Select a percentage level of risk relative to the size of your portfolio. Example – a portfolio of $100,000 might select a risk level of 1.5% so risk should be limited to $1,500 on each trade.

2. Pick a stock and find your precise worst-case exit based on your exit strategies. Example – buying a $25 stock and the exit stop is at $22. Risk is $3 per share so correct position size is 500 shares. ($1500 risk limit divided by $3 risk to your exit point)

Remember, controlling risk is a two step process: use protective it d th k t l i iti l iti iexits and then make sure you control your initial position size.

Advice: for Short-term tradersAdvice: for Short-term traders

Most of the exits discussed in this presentation work best for long-termMost of the exits discussed in this presentation work best for long term trend followers who are able to hold positions until weakness is detected.

Short-term traders may use trailing stops for protection but should plan to exit on strength in order to maximize short-term profits.

Here is one of my favorite exit-on-strength techniques. It is extremely simple and uses Welles Wilder’s RSI indicator. However other over-bought/over-sold oscillators would also work. (Stochastics, William’s Percent R, various bands, etc.)

We will also be discussing the use of targeted exits.

U ATR t t fit t tUse ATR to set profit targets

Units of ATR are perfect for setting profit targets because they contract and expand as volatility changes.

In volatile markets ATR profit targets will be bigger. In quiet markets ATR targets will be smaller.

Short-term traders might expect maximum profits to be about 2 ATRs using a 3-period ATR calculation.

Although it is more difficult and less accurate, targets can also be used by longer-term traders using a longer ATR (20 periods) and a larger ATR multiple (4 or higher).

Th k f tt diThanks for attendingFor additional education and many informativeFor additional education and many informative articles be sure to visit www.SmartStops.net and www.TraderClub.com.

You are welcome to contact me by email at Chuck@SmartStops.net if you have anyChuck@SmartStops.net if you have any questions about this presentation or about SmartStops.

Good luck and good trading!